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Government caps depreciation rate to raise companies' tax liability
March, 10th 2016

Many companies could see their tax liability going up and cash flows getting affected, as the government has capped the rate of deduction under accelerated depreciation. While manufacturing companies would obviously be hit, firms that depend heavily on technology could also see substantial impact.

The government has set the rate for depreciation at 40% a year. Until now, many companies were depreciating assets at around 60%, said industry trackers.While the government's move is part of its efforts to reduce taxation loss in areas where sops were provided earlier, the step has led many companies to redo taxation planning.

Government caps depreciation rate to raise companies' tax liability
"While this (capping of the rate) will help achieve the government's objective of increasing the effective corporate tax rate, the 40% limit will impact cash flows of companies claiming accelerated depreciation, especially those in the wind and solar sector, thereby affecting their financial models," said Rajesh H Gandhi, partner, tax, Deloitte Haskins & Sells.

While the change beginning April 1, 2017 would hurt manufacturing companies the most, many in other sectors, including banking and information technology, could also see the impact.

The earlier accelerated depreciation rate of up to 60% meant that computer sy stems could be depreciated and written off faster, tax experts said. That is not possible under the new rules. Many companies change computers and upgrade IT systems at short intervals and the change in rules means they will have to invest in new systems before the residual value of the existing ones becomes zero.

"With technological adems such as computer ca vancements, items such as computer category can phase out and become obsolete faster and the earlier 60% depreciation rate was a good step. Potentially, now the depreciation rate at 40% doesn't seem to take cognisance of the real economic life of these items," said Sameer Gupta, partner and leader of financial services, tax and regulatory, at EY.

Apart from computers, computer systems and technology, many companies that had invested in solar and pollution control equipment could also see an impact on their cash flows.

"The change in the depreciation rate is more towards the government's policy of reducing the corporate tax rate and phasing out of exemptions and incentives.Though the tax benefit on account of depreciation is more of a timing issues, the reduction in the actual depreciation would mean that the taxation on many companies could go up in the short-medium term." said Amit Maheshwari, partner at Ashok Maheshwary & Associates.

"Depreciation on computers and computer software, pollution-control equip ment, energy-saving device, etc. is currently allowed at higher rates so the change will impact most corporates though ultimately this will be a timing issue," said Gandhi of Deloitte Haskins & Sells.

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